Those Excluded by Institutional Lenders Provide a Ready Pool
The last few years have been tough for the real estate
market. The Great Recession and its ongoing aftermath have
seen millions lose their jobs and homes. Because of
short-sighted and often punitive policies by lenders and
government-backed agencies, the buyer pool for the real
estate market keeps shrinking. But these “outcasts” denied
access to traditional financing represent viable buyers for
sellers willing to consider creative financing. This will
lead to a surge in seller carry-back financing, especially
as Baby Boomers begin to retire and want to downsize in a
slow real estate market.
Whether due to a job loss or a strategic default, when
someone’s home goes into foreclosure the homeowner’s credit
file is branded with a crimson “F” and they are barred from
received a standard home loan for three or more years. The
period for short sales is 2-3 years, assuming the required
decimation of credit can be rebuilt within that time.
Chapter 7 bankruptcy leads to 2+ years suspension of
home-buying privileges for low-down loans backed by Fannie
Mae, Freddie Mac or FHA.
Now, these unfortunate souls are not deadbeats. Most are
just unlucky in that they worked in private enterprise, an
arena unshielded from Depression-level unemployment and
dramatic drops in incomes. So lender attitudes and industry
policies preventing them from buying a home for a number of
years are really akin to “kicking them while they are down.”
But most will eventually recover and find employment or
salvage their small business. Then they will be in the
market for buying a home again. However, they will quickly
discover that they are shunned by the institutional lenders.
Fortunately, their predicament coincides with another
phenomena - the growing number of Baby Boomers that are
either voluntarily or involuntarily (because of job loss)
going into retirement. A good percentage of this generation
wishes to downsize to reduce their expenses in retirement,
but have difficulty selling their home. They are competing
with a glut of foreclosures, investment properties and short
sales for a small pool of qualified buyers. Despite
historically low interest rates, worries about the economy
and a growing number of excluded buyers makes selling a home
today difficult today in many parts of the country. Many
Boomers wind up just renting their home out because they
can’t find a buyer.
The stars are aligning, however. Boomers and others can tap
into the growing population of potential buyers who are
ineligible for normal home loans by offering carry-back
financing that circumvents standard lender approval
criteria. Moreover, retiring Baby Boomers reap significant
tax benefits from receiving payments over time instead of
lump-sum profits. They can also receive a higher price or
enhanced interest rate compared to current market figures.
For many sellers, carry-back financing is the perfect way to
supplement their retirement income with secure monthly
payments at a much higher rate than that received from
bonds, CDs or annuities. In the process, they will also get
renters or installment buyers who are more likely to take
good care of their property.
Buyers benefit too. First, they can buy a home despite being
black-listed by institutional lenders. Second, they avoid
many of the fees (e.g., points) that tradition lenders
charge. Third, the sales cycle is expedited. Overall, it a
much better deal than pursuing a high-rate short-term or
subprime loan to buy a home.
Homeowner seller financing is nothing new. There are several
universally accepted forms of carry-back financing. The two
most popular are:
• Lease-Purchase Option: An installment sale where
the tenant has a purchase option that can be executed at
under specified conditions. Typically, part of the monthly
rent is applied towards the down payment. The buyer gains
title to the property upon satisfying certain
mutually-agreed contractual conditions.
• All-Inclusive Trust Deed (AITD): Here the homeowner
“wraps” existing liens within a new loan. The seller
continues to be responsible for existing loans on the
property, but makes a profit override on the entire total of
all loans, thereby amplifying his return. The buyer gains
title to the property and makes payments to the seller who
in turn pays existing lenders.
In all cases of seller financing, it is the seller who
decides the credit-worthiness of prospective buyers. The
seller assumes the risk normally taken by an institutional
lender. Sellers can be assisted in this process by credit
reports, standard disclosure forms and experienced real
estate professionals. In today’s economy, a recent period of
income disruption and bad credit is often bookmarked by a
past history of stable income and high credit scores on one
end and new employment on the other. This reflects the
profile of hardworking families recovering from job losses
and perhaps a foreclosure or short sale. It is up to the
seller to decide if he wishes to extend credit to them. To
sweeten the pot, additional security such as a co-signer on
the carry-back note or a lien on personal property or other
real estate can also be considered.
Carry-back financing is typically secured by a trust deed or
mortgage instrument on the property that allows an expedited
foreclosure process to recover the seller’s asset should the
buyer default on payments. Pick the right buyer and creative
financing like this is very secure. Worst case, the seller
gets his property back to put it on the market again. And
the initial deal can be structured to ensure that the seller
has sufficient funds to cover costs for this contingency.
The major obstacle to seller financing has been those pesky
“due on sale” clauses that most lenders slip into their loan
documentation. And they interpret “sale” as any event that
impacts their interest in the property (i.e., just about
everything). However, in today’s climate of low interest
rates, defaults and slow-moving real estate, lenders are
usually open to seller financing, although many will demand
a quid-pro-quo by recasting the terms and/or interest rates
on existing liens. Currently, FHA lenders are happy to just
continue receiving loan payments and their HUD overseers
will not usually exercise “due on sale” clauses.
Seller financing is a not a “do it yourself” undertaking.
There are many statutes requiring compliance and complex
legalities that must be addressed. Existing lender
negotiations are an integral part of these transactions.
Moreover, the financial aspects, risks and tax consequences
must be understood and addressed.
Anyone contemplating offering seller financing should enlist
a knowledgeable real estate professional to assist them.
Lease-purchase installment sales and AITDs are proven
processes. Realtors employ standard forms and checklists to
simplify carry-back transactions, avoid pitfalls, minimize
risks and ensure legal compliance. Working with a real
estate agent simplifies the sale for Baby Boomers, allowing
them to confidently focus on the next stage of their lives.
In summary, carry-back seller financing benefits all parties
and is expected to fill the void left by strident lender
policies. Those who are economically getting back on their
feet represent a growing pool of eager buyers. And Boomers
can sell their homes quicker, plus receive a higher return
on their equities while enjoying tax benefits and a
supplemental income during retirement. What’s not to like?!
About The Author
Al Kernek is a Internet marketing consultant, author and Baby Boomer. Learn more about issues facing Baby Boomers seeking to retire on a fixed
or limited income at www.BabyBoomerLifeboat.com which is also an online portal to Websites containing valuable information and resources for Baby Boomers.